1.1 - 1.3 Introduction to micro economics

Question 1

What is Scarcity?

Answer 1

A situation that arises because people have unlimited wants in the face of limited resources.

Question 2

What is the difference/ distinction between needs and wants?

Answer 2

Needs are necessary to sustain human life e.g. air and food. Wants are things people would like to consume e.g. a trip to the cinema.

Question 3

What are limited resources known as?

Answer 3

Factors of production - Capital, Enterprise, Land, Labour

Question 4

What is a distinction/ difference between free goods and economic goods?

Answer 4

A free good is a good with zero opportunity costs. Therefore it can be produced in society in as much quantities needed with zero/ little effort. Free goods are not usually scarce whereas economic goods are scarce with an opportunity cost as a result.

Question 5

Examples of free goods and economic goods.

Answer 5

free goods - air and water
economic goods - healthcare

Question 6

What is the basic economic problem?

Answer 6

The fundamental economic problem faced by society is that of scarcity. This arises because people have unlimited wants in the face of limited resources therefore choices must be made.

Question 7

What are the three economic agents?

Answer 7

Economic agents make choices and decisions these are firms, individuals and governments.

Question 8

What is a positive statement?

Answer 8

A factual statement that can be tested against the facts. A positive statement may be right/ wrong. ‘‘will’’

Question 9

What is a normative statement?

Answer 9

A statement involving a value judgement that is about what ought to be. It cannot be tested as a result. ‘‘should’’

Question 10

What are economic agents?

Answer 10

Economic agents are responsible for making economics decisions using rationality. It’s also important to consider what economic agents are trying to achieve. Reflects incentives that affect behavior.

Question 11

Households-

Answer 11

Make choices about their expenditure ( what goods and services to buy) and through this they need income and therefore make decisions on where to supply their labour to get this income. The objective and aim of households is to maximize utility.

Question 12

Firms-

Answer 12

Make choices in which goods/services to produce, production techniques used and prices products/ services are sold at. Their aim is to maximize profit.

Question 13

Governments-

Answer 13

Make choices on taxation, how to spend tax revenue and how to regulate markets. This ensures a stable economy. The objective of government is to maximize welfare for society.

Question 14

What is Land?

Answer 14

All natural physical resources. It can also be physical space for fixed capital. The reward is rent. Examples include oil,coal, water and wheat.

Question 15

What is Labour?

Answer 15

Human input into production. Human capital is the workforce of the economy. The reward is salary/wages from employment.

Question 16

What is Capital?

Answer 16

Used to produce other consumer goods/services in the future. Examples include machines and buildings. The reward is interest from investments like shares or savings.

Question 17

What is enterprise?

Answer 17

An individual who supplies products to a market to make a profit. This individual organised the factors of production and takes risks. Have a managerial ability. Th reward is profits which is an incentive to take risks as a result.

Question 18

What is resource allocation?

Answer 18

The way in which a society’s productive assets are deployed across their alternative uses. Resource allocation is determined by the three economic agents.

Question 19

Are the objectives/ aims of economic agents applicable to all economies/ individuals?

Answer 19

These objectives are not realistic and not applicable all because of the basic economic problem. Not everyone thinks rationally. Informational failure, persuasive advertising and increasing growth of sales instead of growth of profits and corporate social responsibility.

Question 20

What are incentives?

Answer 20

Economics agents respond to incentives. This changes the behavior of economic agents as a result. Suppose a household realizes the price of a good has fallen. There will be an incentive to consume more of it as the cost has fallen relative to the benefit. If economic agents understand the incentives faced by other agents this may influence behavior as a result.

Question 21

Is incentives effective?

Answer 21

Economics agents do not always respond to incentives they face. They may face conflicting incentives or they may choose not to respond. Incentives do not always bring about the best results in society. We cannot understand the behavior of economic agents unless we make assumptions about what they achieve and how they respond to economic circumstances and incentives.

Question 22

Incentives on economic agents for resource allocation.

Answer 22

For an entrepreneur in a firm the incentive is to take risks for profit. Rewards are positive incentives making consumers better off whilst penalties make them worse off. When incentive are not given properly resources are mis allocated. Firms need an incentive to engage in risk taking so they innovate. Without innovation, production will cost more and there will be a misallocation of resources.

Question 23

What is the coordination problem?

Answer 23

The market mechanism and central planning can be seen in the 3 main economy systems that almost all industrialised economies have adopted
Command economy
Mixed economy
Free market economy

Question 24

What are free market economies?

Answer 24

Where governments leave markets to their own devices, so the market forces of supply and demand allocate scarce resources. There is no government intervention and decisions are taken by individuals and private firms.

• What to produce:
• determined by what the consumer prefers
• How to produce it:
• producers seek profits therefore produce at the lowest cost possible
• For whom to produce it:
• whoever has the greatest purchasing power in the economy, and is therefore able to buy the good

Question 25

What did Adam Smith do?

Answer 25

A free market economist. Created the famous theory of the invisible hand which can be applied to free market economies and the price mechanism. Smith recognized issues with a monopoly power that could arise from a free market.

Question 26

What did Fred Hayek do?

Answer 26

A free market economist who argues government intervention makes the market worse.

Question 27

What are the advantages of a free market economy?

Answer 27

.Firms are likely to be efficient because they have to provide goods and services demanded by consumers. They may lower average costs to make better use of scarce resources (competition)
• The bureaucracy and inefficiency from government intervention is avoided.
• Some economists might argue the freedom gained from having a free economy leads to more personal freedom.

Question 28

What are the disadvantages of a free market economy?

Answer 28

. The free market ignores inequality and tends to benefit those who hold most of the wealth . There are no social security payments for those on low incomes.
• There could be monopolies, which could exploit the market by charging higher prices.
There clities, such as veransumption of demerit goods, which have large negative
• Public goods are not provided in a free market, such as national defence.
• Merit goods, such as education, are underprovided

Question 29

What is a command economy?

Answer 29

• This is where the government allocates all of the scarce resources in an economy to where they think there is a greater need. It is also referred to as central planning.
• Karl Marx saw the free market as unstable. He saw profits created in the free market as coming from the exploitation of labour, and by not paying workers to cover the value of their work. He argued for the “common ownership of the means of production”.

• What to produce:
• determined by what the government prefers
• How to produce it:
• governments and their employees
• For whom to produce it:
• who the government prefers

Question 30

What are the advantages of a command economy?

Answer 30

• It might be easier to coordinate resources in times of crises, such as
wars.
• The government can compensate for market failure, by reallocating resources. They might ensure everyone can access basic necessities.
• Inequality in society could be reduced, and society might maximise welfare rather than profit.
• The abuse of monopoly power could be prevented.

Question 31

What are the disadvantages of a command economy?

Answer 31

• Governments fail, as do markets, and they may not be fully informed for what to produce.
• They may not necessarily meet consumer preferences.
• It limits democracy and personal freedom.

Question 32

What is a mixed economy?

Answer 32

System today. There bre ferent balances ketween command inteleconomies eredity, the governet spends aloon ideo ed Guite and cal, while entral planere free (although
The market is controlled by both the government and the forces of supply and demand.
Goods, suches heathraveded blic atids such as streetlights, roads and the police, and merit
• What to produce:
determined by both consumer and government preferences
• How to produce it:
• determined by producers making profits and the government
• For whom to produce it:
• both who the government prefers and the purchasing power of private individuals

Question 33

What is the job of a market?

Answer 33

To allocate resources in the most efficient way.

Question 34

What are the two types of efficiency in economics?

Answer 34

1. Productive efficiency
2. Allocative efficiency

Question 35

What is productive efficiency?

Answer 35

Production of goods and services by firms is achieved at the lowest possible average total cost, choosing an appropriate combination of inputs(cost efficiency )and producing the maximum output possible from these inputs. (Technical efficiency)

Question 36

What is allocative efficiency?

Answer 36

The right amount of the right products and services are produced where consumer satisfaction/utility is maximised.

Question 37

What is economic efficiency?

Answer 37

• Occurs in a market where both allocative and productive efficiency is achieved.
• society is producing the balance of goods consumers wish to consume at the minimum cost

Question 38

What is inefficiency?

Answer 38

Any situation where economic efficiency is not achieved.

Question 39

Why is the concept of opportunity cost needed?

Answer 39

Economic agents must make choices because of scarcity. In making choices economists must consider possible alternatives necessitating the concept of opportunity cost.

Question 40

What is opportunity cost?

Answer 40

The value of the benefit foregone of the next best alternative when a choice is made.

Question 41

What is a PPC?

Answer 41

A production possibility curve shows the maximum quantities of different combinations of output of two products given current resources and the state of technology.

Question 42

What is trade off?

Answer 42

The calculation involved in deciding on whether to give up a good for another.

Question 43

Why is the PPC curved?

Answer 43

A PPC is drawn concave to the origin because the marginal output resulting from allocating more resources to one particular good may fall. This is also known as the law of diminishing returns. This is because factor mobiles are not perfectly mobile between varying uses.

Question 44

What does the PPC show?

Answer 44

• Trade offs
  -Opportunity costs
  -Inefficient and unobtainable levels of production
  -Increase/decrease in productive potential (economic growth)
  -Difficult economic choices - consumption vs investment

Question 45

Draw a PPC diagram with all 5 points.

Answer 45

Question 46

What are the ways to increase production and therefore shift the PPC?

Answer 46

Q^2CELL
- Quality / Quantity of factors of production

Question 47

What are ways to increase production without shifting the PPC?

Answer 47

-Reallocation of factors of production
-Use up factors of production

Question 48

What happens when the curve shifts favoring one good/service?

Answer 48

The quantity/quality of resources is improved upon to make more out of one of the two goods/services.